Building trust 2017/18 planning priorities for internal audit in the … · 2010. 8. 17. · Governance Retail Banking 06 Regulatory Matters 18 BCBS 239 Retail ... Conduct risk Consumer

Building trust2017/18 planning priorities for internal audit in the South African financial services industry

Building trust | 2017/18 planning priorities for internal audit in the South African financial services industry

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Capital andLiquidity

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InsuranceCapital

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RetailBanking

RegulatoryEconom

icIntroduction

Contents

Section one – outlooks

Section two – planning priorities

Economic

04

BusinessLeadership

12

Culture

Governance

Retail Banking

06

RegulatoryMatters

18

BCBS 239

Retail Distribution Review (RDR)

Financial crime

Conduct risk

Consumer credit

Regulatory

05

RiskManagement

15

Embedding of risk

managementframeworks

Risks on the fringe – social

unrest and Cyber

(Insurance risk pricing for

Cyber)

Binder holder audits

Capital Markets

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24

Bank capital

SAM

Insurance

09

Operationsand IT

26

Operationalresilience

Assurance over third-party

management

Project management

Cyber

Data Managementand Governance

Digitisation

Investment Management

10

Accounting and tax

33

IFRS 9

IFRS 15

IFRS 17

Non-financial reporting

frameworks


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Introduction

In an era of continued challenge around conduct and behaviour for firms, regulators and Boards are more aware of the issues and prepared to act.

This leaves a critical question for South African Internal Audit functions to address – how does their work provide confidence in the conduct and behaviour of firms and ultimately help build trust with customers and clients? Are they focused on the priorities that matter?

In addition, we should expect market disruption, innovation and changing business models to put pressure on Internal Audit functions. The expectations on Internal Audit to cover the basics while adding more insight and value – being a genuine partner and critical friend – continuing to grow. Many organisations are seeking to enhance growth and returns to build market share or access new technologies through acquisition, development into new markets or products, or partnerships to access talent. This adds pressure on Internal Audit to have a credible opinion on topics which in some cases didn’t exist a year ago. Making an impact is becoming more challenging.

So in this year’s publication we have developed the format from previous editions to help functions make this impact:

• Outlooks have been included covering the economic and regulatory changes as well as key market developments into 2017. We hope these add context to the financial services landscape that organisations will be facing to help Internal Audit functions focus on what truly matters

• As we highlighted in our recent global survey of Chief Internal Auditors “Internal Audit at a crossroads – evolution or irrelevance” there remain a number of important challenges for Internal Audit functions. Most expect their organisations and functions to change substantially in the next few years yet lack the impact and influence they desire. There remain gaps in certain skills including analytics and IT and methods of effective communication. While stakeholders expect more forward-looking insight around risk, strategy and business performance the expectation on Internal Audit to make an impact is now

• Within each planning priority we have tried to differentiate the impacts on different sectors within financial services, so depending where your organisation is positioned, that planning priority provides more tailored impacts.

This publication provides you with our thinking and we hope it proves useful as you plan and prioritise for the 2017/8 audit years.

Intr

oduc

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perationsand IT


RegulatoryM

attersRisk

Managem

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LeadershipInvestm

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InsuranceCapital

Markets

RetailBanking

RegulatoryEconom

icIntroduction

Section one – outlooks

ContactsAccounting

and TaxO

perationsand IT


RegulatoryM

attersRisk

Managem

entBusiness

LeadershipInvestm

entM

anagement

InsuranceCapital

Markets

RetailBanking

RegulatoryEconom

icIntroduction


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Economic outlook

The South African economy continues to be mired in a slow or low growth economic trap. At a global macro level, emerging markets continue to be negatively impacted by rising perception of risk, South Africa included. The prospect for normalised interest rates in the US economy, unsustainable current account deficits, inefficient budgetary spending, serviceability of debt, the downgrade of the sovereign and ultimately poor political governance all feed this negativity vis-à-vis toward South Africa. Ironically, sentiment toward emerging markets has become far more positive from Q1 this year, but South Africa is differentiating itself from this upward cycle.

The prospect of increased fiscal spend in the US economy resulting in rising debt and thus higher interest rates is likely to fuel a stronger dollar in the medium term, which is not positive news for the value of the ZAR currency but will certainly bolster the share prices of JSE listed firms with externalised earnings.

The growth outlook for South Africa remains subdued without any dramatic structural or political shift in the country. The rough forecast of around 1% by the South African Ministry of Finance is arguably a best case scenario. The intractable challenges of rigid unemployment, mismanagement of state-owned enterprises, the corrosive impact of corruption within the public sector and at times directionless policy will continue.

In light of the ANC’s general conference to be held in December, we can expect rising political risk in the country which will not be conducive to supporting business conference. Perhaps post-conference there will be a new political impetus provided to the economy.

With the South African economy not growing, organisations will increasingly reduce costs and be less willing to invest in an economy which suffers from a deficit of confidence. But the longer-term impact of this is to augment the competiveness of a private sector which will be well positioned to benefit from renewed growth over the medium term.

Econ

omic


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InsuranceCapital

Markets

RetailBanking

RegulatoryEconom

icIntroduction

Regulatory outlook

The South African regulatory expectations continue to evolve and expand. Regulatory attention has in most instances moved beyond the planning phase and is now focused on implementation. Strong ethics, culture and accountability at every level of the organisation are now as important as financial resilience.

New regulatory proposals and expectations across a range of conduct, financial crime and prudential topics that have recently come to the fore include amendments to the fit and proper requirements for financial services providers, the Retail Distribution Review (RDR), the draft Market Conduct Policy Framework (“the Market Conduct paper”), the Financial Sector Regulation Bill (FSRB), the Financial Markets Act (FMA) Regulations, the Conduct of Business returns (CBRs), Financial Intelligence Centre (FIC) Amendment Act and Solvency Assessment and Management (SAM), other areas of financial crime (i.e. Cybercrimes and Cybersecurity Bill) and consumer credit, among others. Furthermore, the Financial Services Board (FSB) has published for public comment the proposed amendments of fit and proper requirements for Financial Services Providers (FSPs) which repeals the existing legislation in its entirety and determines new fit and proper requirements for FSPs, Key Individuals (KIs) and representatives.

A key point from the proposed amendments to the fit and proper requirements to note is that the honesty and integrity of a company must be demonstrated through its corporate behavior and through the personal behaviour of its directors and KIs.

The FSRB, once signed by the President, will formally mandate the South African Reserve Bank (SARB) to maintain, promote and enhance financial stability, at both a macro and micro level (institutional level), in South Africa alongside its primary price stability mandate. Consequently, a particular area of supervisory emphasis currently is each institution’s ability to respond to shocks or crises. The current list of possible risks is long with consequences for macroeconomic and financial market instability and dislocations. These put the spotlight on IT infrastructure, contingency planning and stress testing, among others.

When tackling regulatory change, many organisations have traditionally operated reactively, only making changes in response to a particular regulatory deadline, supervisory direction or other type of regulatory pressure. However, increasingly organisations have started to shift towards a more proactive stance, by taking a strategic approach to managing regulatory change and by establishing stronger links to business strategy and engagement with the regulators.

A forward-looking regulatory strategy creates opportunities to better align regulatory responses with business objectives. It can also improve the efficiency of implementation. By identifying the connection points between regulatory and business strategies – instead of managing regulatory strategy as a side activity – financial institutions can discover ways to achieve common objectives more efficiently and align compliance activities with their broader organisational goals.

Regulatory


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Retail Banking outlook

Operational and conduct risks The use of high frequency, electronic and algorithmic trading practices within wholesale markets increases the susceptibility to operational risk events and poor conduct outcomes for clients. Often this is a result of historical programming development, IT issues and weaknesses in governance. While the global regulatory landscape is both comprehensive and complex, there is a growing regulatory expectation that firms demonstrate better compliance of electronic trading regulatory requirements. This has led to a greater focus within firms to have a common, homogenous approach that is applied in electronic algorithmic trading governance.

Innovative technologies Many capital markets institutions are currently piloting and adopting innovative technologies, some of which are likely to have far-reaching consequences for their value chains, processing capabilities and control frameworks. While many fintech, and especially blockchain initiatives are in early stages, the implications for internal audit functions are significant and will require close interaction to maintain strong business and technology controls.

Prudential regulatory changesThe Basel Committee on Banking Supervision (BCBS) is in the process of finalising its latest proposals, often referred to as ‘Basel IV’. The core theme underpinning the new BCBS proposals is a desire to reduce the variability in capital ratios arising from modelling differences between banks as well as between standardised and internal model-based approaches.

BCBS is approaching the problem from multiple angles:

• Harmonising modelling practices across the industry through, for example, the Fundamental Review of the Trading Book (FRTB), to be implemented in 2020

• Revised standardised approaches for capital calculations across Credit Risk, Securitisations, Counterparty Credit Risk, Market Risk and Operational Risk

• A revised Capital Floor for models, replacing the existing capital floor based on Basel IV.

Banks are currently assessing the impact of the Fundamental Review of the Trading Book (FRTB) and are reviewing the current target operating platform for market risk, taking into account platform capabilities across both front office and risk areas and aligning market risk processes, analysis and reporting in line with these impending regulatory changes.

Interest Rate Risk in the Banking Book (IRRBB) expected implementation date is during 2018. The Final Standards contains 12 principles 9 relating to banks (including sound methodologies, risk appetite and limits, internal reporting, identification of IRRBB, external disclosures, data, controls and model risk management); 3 relating to supervisors (review of bank’s IRRBB framework, collaboration among supervisors, identification of outlier banks).

South African banks are keeping abreast of the international developments regarding the proposed changes to the derivation of risk weighted assets as it pertains to the move towards greater reliance on more standardised models (application of floors) with less reliance placed on internal calibrations.

Reta

ilBa

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What retail banks should look out for in 2017?

Cost savings

Managing innovation


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and TaxO

perationsand IT


RegulatoryM

attersRisk

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LeadershipInvestm

entM

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InsuranceCapital

Markets

RetailBanking

RegulatoryEconom

icIntroduction

Capital Markets outlook

In 2016, the National Treasury released, for comment, the third draft of the Financial Markets Act (FMA) Regulations. The draft FMA Regulations brings the National Treasury closer to its objective of reducing the risk of over-the-counter (OTC) derivatives in South Africa. As a member of the G-20, South Africa is committed to aligning its regulatory framework to the principles and recommendations put forward by global standard setting bodies, including the Basel Committee on Banking Supervision (BCBS), the International Organisation of Securities Commissions (IOSCO) and the Financial Stability Board. Per the National Treasury, given that a significant share of South Africa’s OTC derivatives transactions are cross-border, it is important to be mindful of domestic and international economic developments to ensure consistency with international best practice.

Operational and conduct risks All OTC derivative providers (ODP), that is market participants that originate, issue, sell or make a market in OTC derivatives, will be required to gain authorisation to act as an ODP, subsequent to the approval of the amendments to the FMA and the Regulations. ODP authorisation is expected to begin 6 months after coming into force of the FMA and the Regulations. The criteria prescribed includes the provision to prove its financial soundness as part of a fit an proper assessment and to establish, maintain and implement written policies and procedures for categorisation of clients and counterparties.

All ODPs are required to comply with the code of conduct set out in the FSB’s draft Board Notice, the code of conduct is binding to all ODP’s directors, officers and employees, clients and counterparties. The code of conduct is expected to come into force during the first half of 2018 and will require ODPs to establish, maintain and implement written policies and procedures for proper risk management and to manage operations and activities. The proposed additional risk management requirements covers trading relationship documentation, trade confirmations to promote legal certainty of the trades, portfolio reconciliations, portfolio compression of non-cleared open OTC derivative transactions, dispute resolution and notification to authorities

and safeguarding collateral. The aforementioned risk management requirements will place additional pressure on already scarce first- and second-line risk management and compliance resources and may have significant systems and data implications.

Trade reporting In order to monitor concentration build-ups that may pose systemic risk, it is important that market participants report details regarding exchange traded derivatives and OTC derivative transactions, including relating to securities financing transactions (SFTs) and other specified types of derivative trades, to a licensed Trade Repository (TR) to be centrally stored and easily accessible. The FMA Regulations provide for all OTC derivative transactions to be reported on a licensed TR. The requirements for licensing of a TR in South Africa have been developed, however exact timelines of when we can expect the first TR to be licensed is not clear. In the European Union (EU), trade reporting requirements covering over 90% of OTC derivative transactions were in force as at 30 June 2016 in 19 out of 24 member jurisdictions. Challenges have been identified around TR data quality, the aggregation of data across TRs, and legal barriers to reporting complete data to TRs and to authorities’ access to TR-held data. A number of Financial Stability Board work streams have been set up to address these issues. South African firms should ensure

CapitalM

arketsWhat capital market participants should look out for in 2017?

Operational andconduct risks

Innovativetechnologies


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that, where it is currently enhancing its trade systems or planning to effect systems changes (i.e. to take into account the requirements for data and systems changes for the impending fundamental review of the trading book (FRTB) requirements), it future proofs its trade systems to accommodate future trade reporting requirements.

Cost of trading There are three main elements to the costs that will be incurred by OTC derivatives in the future; new margin requirements (initial margin and variation margin), capital charges for exposures, and other compliance costs, mainly resulting from additional reporting requirements. In addition to the increases in costs, some market-making dealers may also see revenue fall, e.g. if greater transparency leads to a narrowing in margins.

There are cost implications for all market participants transacting in OTC derivatives; financial counterparties, including market-making dealers; large buy-side customer such as mutual funds, pension funds, hedge funds and insurance companies; and also non-financial counterparties such as industrial companies using OTC derivatives for hedging purposes.

Compliance costs, mainly resulting from additional reporting requirements will include; requirements such as reporting daily valuations to TRs; collateral reporting; account segregation and record keeping. These will be incurred regardless of whether the derivative is centrally cleared or not and will be directly incurred at the level of the transacting firm.

From a practical perspective, significant client outreach actions as well as the need to revisit and potentially amend existing legal documentation such as International Swaps and Derivatives Association (ISDA) agreements, these can be lengthy and time consuming programmes. There will also be significant operational considerations, particularly in relation to segregation of client assets and establishing processes to deal with expected increases in disputes. Firms need to make sure that they have robust operational infrastructure in place including efficient post-trade processing.

Innovative technologies Many capital markets institutions around the world are currently piloting and adopting innovative technologies, some of which are likely to have far-reaching consequences for their value chains, processing capabilities and control frameworks. While many fintech and especially blockchain initiatives are in early stages, the implications for internal audit functions are significant and will require close interaction to maintain strong business and technology controls. These developments will become more pervasive and relevant in the South African context over time.

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ContactsAccounting

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RegulatoryM

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InsuranceCapital

Markets

RetailBanking

RegulatoryEconom

icIntroduction

Insurance outlook

Economic and market developmentsSlow GDP growth in SA and resultant reduction in consumer disposable income is putting pressure on consumers’ savings, and this is impacting on sales and retention recurring premium saving and investment products. This in turn is putting pressure on per-policy costs and a placing a focus on efficiency of operations.

Digital innovation Many parts of the insurance industry now are either technology related or have technology as a key driver. Trends such as growth of peer-to-peer insurance, cyber insurance, gamification, aerial & digital imagery and customer adherence apps will have a larger role to play in future. Start-ups are emerging in the insurance sector with fresh, innovative and potentially popular business models.

Internet of Things and Big data The growth of internet connected devices and sensors, which are projected to number 50 billion by 2020, is changing the insurance market and bringing consumers closer to insurers. Through the use of low cost of sensors, improved communication and increased data processing power, the Internet of Things is fuelling the rapid growth in the availability of real-time or near-real-time information – a trend often referred to as ‘big data’. Insurers who can exploit this information to identify customers’ needs and risks and to support better pricing, underwriting and loss control will have a distinct competitive advantage over their peers.

As competition to access more affluent segments of the market, to drive product and revenue growth, the ability to access this segment will require digital investment, particularly around enhancing the financial planning process and providing a seamless experience across a wide range of products.

Technology under-investmentMany insurers are playing catch-up after a period of under-investment in technology. With new entrants operating under new agile technologies, legacy insurers need to invest in upgrading and/or replacing core systems to compete with the same level of efficiencies and agility. Enhanced marketing capabilities have emerged, enabling omni-channel interactions and a move away from a “direct or intermediated” to “direct and/or intermediated”, however investment in and management of technology for customer engagement, connectivity, data and insights is required to unlock this potential.

Given the amount of data stored by insurers, and the trend to digital engagement with customers, cyber fraud is becoming a real risk which insurers need to invest in to manage.

New sources of, and management of, client data are needed to move towards a holistic analytic capability that drives growth of on-selling, efficiency in underwriting while also enabling effective fraud prevention and detection, as well as risk management.

Insurance

What insurers should look out for in 2017?

Conduct

Digital innovation

Internet of Things and Big data

Change in businessmodels


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Dual regulatory environment for insurersThe emergence of two regulators (the FSB monitoring market conduct and the SARB monitoring prudential matters for banks and insurers) creates a situation whereby the insurance prudential monitoring team from the FSB will move over to the new Prudential Authority. This may put pressure on insurers around engaging on the SAM returns as this integration occurs.

Evolving customer expectationsCustomers are demanding more simplicity, partly led from a conduct regulation perspective, but also as consumers expect more transparency and simplicity in products as well as the digital channels available to customers to interact with insurers.

Change in business models Over the last five years, insurance business models have evolved significantly to embrace the digital age, often through an increased use of outsourcing and specialists. As such, insurance business models are exploiting growth opportunities, to meet ever-changing consumer needs. Similarly, delegated underwriting and claims handling firms are increasingly engaged, either to bring in specialist skills or access new markets globally.

Conduct The Financial Service Board (FSB) continues to emphasise the need for insurers to evolve through demonstrating proactive management of market conduct risks. Consideration of market conduct risk (such as the unfair treatment of customers) should be considered across the entire organisation, as well as where areas of the business are outsourced.

The Retail Distribution Review (RDR) will bring change to how insurers do business and distribute products through the use of digital channels and automated advice solutions. As commission rules alter and pressure is put on firms to decrease costs and show customers increased value for money, the RDR may accelerate certain digital solutions, as was seen in the UK in 2012, albeit for investment products.

Insu

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RegulatoryEconom

icIntroduction

Investment Management outlook

Fintech offerings will provide investors and smaller firms greater customisation and sophistication in their investments, thus drive market innovation and potential for expansion.

In South Africa, the impact of the RDR will start to be felt in the coming years which will have the affect of accelerating some of these trends, much as was the case in the UK in 2012.

Key considerations:

• How will the playing field be impacted by innovation-driven and other disruptions?

• Is a new segment of investors emerging, and if so, how do firms target them?

• What parts of the investment management value chain will be influenced first?

Industry and Technology Scale and process advantages of established investment management players are diminishing over time. The playing field will level as firms of all sizes take advantage of emerging networks and platform-based services to lower cost, improve compliance and focus on markets with true competitive advantage. Product and Customer Cognitive technologies and automation will enable the targeting of new investor segments through lower costs and increased customisation. Increased sophistication of robo-advice will continue to alter distribution models, forcing fewer traditional advisers to move upmarket. The impact of RDR on advisors may accelerate this further.

Business and operations Strong above-market performance history has helped traditional investment managers navigate headwinds ranging from slowing fund inflows to market-share gains by absolute return and passive strategies. Rising transparency and consequent fee and margin pressure, remain.

Interest in managed services solutions and outsourcing to drive front and back office cost savings will accelerate, both in core trading and customer records management. In the UK several big fund houses have joined forces in testing blockchain technology by cutting out intermediaries and reducing staff. It is also viewed that blockchain will likely be gradually adopted for reconciliation, clearing and settlement, which would increase accuracy and speed while decreasing costs. Such developments should be monitored closely by South African firms to understand the impact of these changes and to benefit from the foresight these efforts may provide the South African market.

Investment managers are under growing pressure to provide better value-for-money products, with clients and the FSB calling for a re-think of cost transparency and cost structures.

What investment managersshould look out for in 2017?

Industry and technology

Product andcustomer

Business and operations

Investment

Managem

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Section two – planning priorities

ContactsAccounting

and TaxO

perationsand IT


RegulatoryM

attersRisk

Managem

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LeadershipInvestm

entM

anagement

InsuranceCapital

Markets

RetailBanking

RegulatoryEconom

icIntroduction


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InsuranceCapital

Markets

RetailBanking

RegulatoryEconom

icIntroduction

Business Leadership

CultureCulture can be thought of as a system of values, beliefs and behaviours that influence how work gets done within an organisation.

Culture in Financial Services (FS) firms is moving towards the top of the agenda for regulators, investors and consumers. As global regulators pay more attention to this in the wake of international misconduct scandals, South African FS firms need to plan for this within the local regulatory context around the Treating Customers Fairly (TCF) regime.

The King IV Report on Corporate Governance for South Africa (King IV) has outlined ethical culture as a key outcome for which governance structures and leadership teams are responsible for attaining.

While there are certain cultural characteristics that are generally considered to contribute to positive or negative outcomes, there is no single ”good” culture. Each firm needs to articulate its own desired culture, consistent with its strategy and risk appetite. To be effective, a target culture statement needs to include both principles and specific, measurable behaviours. These desired behaviours can then be used to form the basis of a culture assessment.

Regardless of how strong or weak a firm's culture is currently, it needs to be understood and actively managed. If it is not, it can rapidly become a serious threat to the reputation and success of the firm. Data on culture alone is not sufficient – Management Information (MI) must include analysis that leads to action.The following represent a number of important external impetuses regarding taking culture seriously:

• King IV has listed ethical culture as a key outcome for governance structures and leadership to aspire to

• The FSB’s TCF regime continues to focus on culture as a key outcome for gaining the trust of customers

• 2016 Financial Reporting Council (FRC) paper on Governance

• Standard & Poors: “Approach for assessing Enterprise Risk Management”

• Group of 30: Banking Conduct and Culture. A Call for Sustained and Comprehensive Reform

• 2013 Chartered Institute of Internal Auditor’s “FS Code”: “Effective internal audit in the financial services sector”

• Increasing stakeholder pressure: e.g. general public, media, politicians, shareholders – even Hollywood through “The Wolf of Wall Street”, “The Big Short” etc.

Applicable sectors

Retail Banking

Capital Markets


Insurance

BusinessLeadership


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The following represent a number of important internal impetuses regarding taking culture seriously:

• Competitive advantage: reduces chances of significant setbacks and improves performance

• “Glue”: for aligning strategy, succession plans, risk appetite, risk management and remuneration

• Demonstrating it is being taken seriously: active involvement by Boards, non-executive directors, Board Committees (Audit and Risk; Remuneration)

• Measuring it to strengthen it: Internal Audit audits; Risk Management oversight; HR guidance.

The impacts on each sector are considered consistent. What can Internal Audit do

to address this?

• Check that Management Information (MI) on culture is objective wherever possible, is drawn from a range of sources and contains evidence-based analysis and recommendations

• Make sure that MI is supported by appropriate governance and capabilities, including people, processes and IT systems

• Carry out specific culture assessments or consider culture as part of their root cause analysis on all audits.

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RegulatoryEconom

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BusinessLeadership

GovernanceThe King Committee published King IV on 1 November 2016. King IV is effective in respect of financial years commencing on or after 1 April 2017.

The Code is principle based and follows an outcomes-based rather than a rules-based approach. The governance outcomes that should be realised include ethical culture, good performance, effective control and legitimacy.

Combined assuranceThe combined assurance model should be implemented to assist the board in satisfying itself that the following objectives are met:

• Enabling a sound control environment

• Integrity of information used for internal decision-making

• Integrity of external reports

Internal Audit should continue to provide assurance over governance, risk management and control processes. The risk-based function should consider its contribution and role within the combined assurance model and support the audit committee’s assessment of the effectiveness of the model.

King IV recommends that periodic independent assessment/assurance is provided over the following:

• Ethics monitoring programmes

• Effectiveness of risk management

• Effectiveness of organisation technology and information arrangements

• Compliance management

Responsible InvestmentKing IV states that the board of and institutional investor should ensure that responsible investment is practiced by the organisation to promote good governance and the creation of value by the companies in which it invests.

What can Internal Audit do to address this?

• Risk-based planning to include the assessment of ethics management, risk management, information, technology and compliance

• Test whether subsidiary governance systems are in line with group governance frameworks and key decisions and approvals are appropriately delegated and escalated as needed

• Examine whether the policy has been designed and approved to reinforce the adoption of a recognised responsible investment code, principals and practices

• Test whether there is sufficient evidence to support the adoption of responsible investment decision-making.

Applicable sectors

Retail Banking

Capital Markets


Insurance


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Risk Management

Embedding of risk management frameworksA risk management framework is embedded when the organisation is risk intelligent. Specifically, when everyone understands the organisation’s approach (arrangements and design) to managing risk, takes personal responsibility to manage risk in everything they do and encourages others to follow their example. These principles are applicable to all sectors within the financial services industry, however, in the section below we have focused on recent regulatory updates for the insurance industry specifically.


• Awareness of the ‘Risk Strategy’: evaluate whether leaders, managers and the risk function know the risk strategy and how the framework’s systems and risk function capabilities are targeted to evolve to enable the business strategy

• Risk intelligence or risk culture: examine peoples perception of the risk management framework at all grades, geographies and business lines throughout the organisation, in proportion to everyones ‘day-to-day’ risk related activities

• Internal audit should review the risk management systems on a regular basis to ensure the system is effective

• Internal audit should consider the review of risk response plans such as crisis management, business continuity and contingency planning.

The drivers for embedding risk management frameworks are increasing prudential regulatory pressures, reduced operational loss exposures (such as fines and remediation costs from compliance breaches) and increasing competitive advantages deriving from informed management decisions.

For insurers, internal auditors also need to be conscious of their regulatory responsibilities towards risk management in terms of Board Notice 158 (BN158). This requires Internal Audit to have a view of the effectiveness of risk management. The Head of the Actuarial Control (HAC) plays a critical role in the overall risk management framework, therefore in order to have a holistic view of risk management internal audit must have the necessary skills and experience to understand and review the role and output of the HAC

Risk governance has been incorporated in the King IV code with an emphasis on opportunity identification during the strategy setting process. King IV recommended a number of risk management practices based on established frameworks and standards but focuses on business resiliency through crisis management and continuity planning. What is the impact on Insurance?BN158 issued by the FSB has specific requirements for the control functions of long-term insurers. This includes the governance and risk framework for the insurer and the roles and responsibilities of the risk management function as well as internal audits role for providing assurance over the risk management function and process. BN 158 requires the establishment of a Risk Committee and an independent risk management function. The function should establish and maintain a system to identifying, assessing, monitoring, managing and reporting of all current and emerging material risks.

Applicable sectors

Insurance

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Risks on the fringe – social unrest and Cyber (Insurance risk pricing for cyber)Cyber, as a class of business, is growing significantly in the commercial and specialty insurance market. There is also increasing pressure on insurers to widen terms and conditions in a number of lines of business, in order to provide cover for cyber exposures. Furthermore, there are also a large number of policies where coverage for cyber is not specifically included or excluded.

Cyber is a rapidly developing area of risk. In particular:

• Aggregation: – The increasing frequency of cyber-attacks leads to increased potential for aggregation of exposures. It is important that insurers monitor these against their risk appetite.

• Reserving: – Reserving uncertainty due to lack of claims experience, historical data and market benchmarks

– Challenges with the evaluation and monitoring of cyber reserves due to the immaturity of cyber insurance mean that reliance on standard reserving techniques is less appropriate

– There is a threat of under-reserving given the continuing soft market conditions

– The risk that claims are not being notified on a timely basis to insurers due to fear of reputational damage and therefore this increases the uncertainty in reserving.

• Coverage: – Coverage is dependent on the facts of the claim and the terms and conditions of the particular policy. If this is not clear to the cyber policyholder, there are potential conduct risks.

Insurance companies and Lloyd’s of London syndicates need to understand the cyber risks they are writing, the aggregate risk they are exposed to, the market trends for cyber-crime, and assess that their reserves are sufficient to meet potential future liabilities.


• As part of the Risk Management audit, testing of the setting and monitoring of the insurer's risk appetite for exposure to cyber-attacks and reporting against that risk appetite to the Board

• Perform specific cyber underwriting audits, as a newer class of business, with scope areas including pricing, risk aggregation and exposure management, conduct risk and reserving.


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Binder holder audits

There continues to be regulatory focus by the FSB on how insurers oversee and control their outsourced providers, especially those providing binder functions.

This level of regulatory scrutiny is driving the need for higher quality binder holder audits to better demonstrate oversight and control, including being risk-based and proportionate, with clear evidence to support the results.


• Assess the effectiveness of the Delegated Authorities teams’ risk-based oversight framework with respect to coverholders and claims handling agents, and the ability of the firm to robustly evidence the approach it has taken, standing up to regulatory scrutiny

• Assess the quality of binder-holder audits being performed, including adequacy of scoping, the quality of reporting and the rigour with which findings are being monitored and tracked to resolution.

Applicable sectors

Insurance

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BCBS 239 Risk Data Aggregation and Risk Reporting

The BCBS 239 Principles for effective ‘Risk Data Aggregation and Risk Reporting’ apply to Global Systemically Important Banks (G-SIB) (and Domestic Systematically Important Banks (D-SIB) three years after recognition) with the objective of improving each institution’s ability to manage their risks better through improved risk-data aggregation capabilities and risk reporting practices. The principles cover:

• Overarching governance and infrastructure – banks should have a strong governance framework in place, risk-data architecture and IT infrastructure (Principles 1 and 2)

• Risk Data Aggregation – banks should develop and maintain strong risk data aggregation capabilities so that risk-management reports reflect the risks in a reliable way (Principle 3, 4, 5, 6)

• Risk Reporting Practices – risk reports based on risk data should be accurate, clear and complete. The reports should be presented timely to the appropriate decision-makers that allows for an appropriate response (Principles 7, 8, 9, 10 and 11)

• Supervisory review, tools and cooperation – applicable to supervisors only and covering review of compliance with the principles (Principles 12, 13 and 14).

The SARB directive issued in February 2015, D2/2015, required all South African D-SIBs and banks that are part of a G-SIB group to comply with the BCBS 239 principles by 1 January 2017, or in the case of a bank part of a G-SIB group to comply with the G-SIB timelines prescribed by the international supervisor. The D2/2015 required the SARB to assess the requirement for non-D-SIB banks to comply with the BCBS 239 principles on a case-by-case basis and had to inform the particular non-D-SIB bank in writing should they have to comply with the requirements of the directive.

Institutions which fail to demonstrate sufficient progress towards full compliance with the Principles, will be subject to punitive actions imposed by Supervisors, such as additional Pillar 2 capital charges.

Ongoing independent validation of compliance (which should be considered separately from internal audit work) is a requirement of the Principles and in addition, BCBS publication D348 stated that independent evaluation of compliance should be carried out (by either internal or external auditors).

Regulatory Matters

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Retail Banking

Capital Markets

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What is the impact on banks?Compliance with the 11 principles was targeted for 1 January 2017 for South African D-SIBs and other designated banks. Most banks are still in the process of properly implementing the principles and measuring compliance with the principles are made more difficult as banks need to interpret the requirements and demonstrate

qualities such as “completeness,” “timeliness,” “adaptability” and “accuracy” which can have different meanings, and potentially different metrics, when applied to different risk types (e.g. credit, market and liquidity).The SARB issued directive D5/2016 in September 2016 informing all banks who are required to comply with the BCBS 239 principles to instruct its

internal auditors, or a combination of internal and external audit, to conduct a granular verification and validation of the evidence relating to the extent of the banks compliance with the BCBS 239 principles. A report should be furnished to the SARB by 30 September 2017, detailing the findings.

Challenges facing banks Key considerations

Lack of infrastructure and quality data:

• Inconsistent infrastructure and data quality hinder ability to aggregate risk during a crisis

• Issues with consistency and quality due to different degrees of data granularity

• Decision-making processes compromised due to lack of complete, accurate and up-to-date data

Enhance governance

• Define organisational roles and responsibilities

• Develop policies and procedures

• Communicate and validate roles – proof concept

Define risk data aggregation and reporting (RDAR) Scope

• Risk only or include finance?

Data quality and lineage issues

• Data sources identified and mapped

• Future state alignment

Defining interpretation of BCBS 239

• Scope of reports

• Interpretation of compliance

• Ability and appetite to close compliance gaps

Assign Executive accountability in driving adherence is critical at the inception.

An Evidencing Framework needs to be developed early on – this must detail how proof of compliance will be gathered, by whom and how it will be presented to Internal Audit and the Regulators.

Increasing reporting requirement and increasing frequency:

• Regulators asking for large and greater granularity of information

• Management is looking for more information to derive insights and plan strategy

• Siloed processes, fragmented data and manual interference

Unclear data ownership/stewardship – unclear who is responsible for making decisions that impact how data is collected, used, maintained and protected

Ineffective data access – data is not always centrally available requiring requests for data search and retrieval/extraction via intermediaries

Investment Management and InsurancePure investment management firms and the insurance industry is currently out of scope of BCBS 239. However firms may consider starting to implement the principles, understanding the benefits and the positive developments arising from better risk-data quality and improved risk management.

Typical challenges and key considerations:

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Retail Distribution Review (RDR)

The Retail Distribution Review (RDR) will have a far reaching impact on the insurance and investment management industries in South Africa.

As firms begin to implement plans and strategies to respond to the required changes, Internal Audit’s role needs to have a view on the change programme and particularly whether firms have assessed the impact that the changes will have on product and distribution channel profitability and what strategic choices have been made to combat the likely market shifts.

One of the key impacts of the RDR in global markets was around the acceleration of technology within the investment management industry, from a product and distribution perspective. As pressure on lowering costs within the product lifecycle increased, use of low cost passive products, direct to customer distribution channels and robo-advice solutions also increased. This trend is also likely to play out in South Africa.

Internal Audit needs to be in a position to ask the right strategic questions of the organisation to ensure that all critical elements of RDR have been considered and that the relevant strategic plans have been developed and implemented.

What is the impact on Retail Banking?The RDR will not have a direct impact on traditional retail banking products, however, certain products sold alongside banking products (e.g. credit life insurance) will be impacted by the RDR. In such bancassurance models, firms need to assess how the RDR will impact the profitability of these products and the bancassurance models as a viable distribution channel.

What is the impact on Capital Markets?The RDR will not impact Capital Markets due to its focus on the retail customer. What is the impact on Insurance?Insurance companies have many important questions to consider as part of the new regulations. These are across the insurance lifecycle and will impact product and customer strategies across the industry. From advisors being challenged by the amount of commissions they may earn, to the design of products and commission systems that require updating, to the amount of monitoring product providers need to perform over advisors – the changes are impactful and the amount of change will bring many challenges.

What is the impact on Investment Management?Like the insurance industry there are many aspects for investment managers to be concerned about. The banning of commission on the sale of investment products is probably the most critical change as this will impact the ability and the appetite of advisors to sell investment products in the market. Where advisor business models are unable to survive, investment managers will require alternative direct distribution channels. As customers become more aware of product costs through improved disclosure, low cost products may become more popular. These product and customer questions become key to investment managers’ business strategies.

Applicable sectors


Insurance


• Play a role in monitoring the progress of the organisations RDR projects in the more traditional role of project assurance

• Be a strategic business partner who assists in determining the direction that the organisation takes in its response to the RDR. This can be achieved through asking the right strategic questions of the RDR program which ensures that all key considerations have been addressed adequately.

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Financial crime

The SARB’s unrelenting focus on financial crime continues, particularly in relation to anti-money laundering (AML) and combating the financing of terrorism (CFT), as illustrated by its endured use of administrative sanctions to enforce AML and CFT compliance and to ensure that banks implement stringent preventative and detective control measures.

The amended FIC Act aligns South Africa’s AML and CFT regime to international standards set by the Financial Action Task Force, an inter-governmental body that develops and promotes policies to combat money laundering (ML) and terrorist financing (TF) and reaffirm South Africa’s commitment to curtailing financial crime.

Financial institutions have been strongly encouraged to conduct assessments of the risks posed by their customers and institute sophisticated systems and controls which prevent financial crime.

What is the impact on Retail Banking and Capital Markets?Retail banks are encouraged to implement appropriate AML tools and technology to provide the functionality and automation required to identify and effectively manage ML and TF risks.

What is the impact on Investment Management?Fintech companies are making inroads into the wealth and investment management space, leading to digitisation and altering aspects of the traditional model of client experience. While fintech companies may appear challenging for the investment management business model, there is an opportunity to leverage them for enhancing AML systems and controls.

What is the impact on Insurance?Insurance firms should continue to leverage off of AML tools and advancements in the banking sector to implement comprehensive compliance programs and manage financial-crime risks by making use of analytical tools and technology.


• Consider the available evidence of the implementation of the governance framework and confirmation that a firm has placed suitably skilled resources in key business areas, aimed at embedding a culture which prevents financial crime.

Applicable sectors

Retail Banking

Capital Markets


Insurance

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Conduct Risk

Retail Conduct RiskIn South Africa, issues of mis-conduct have recently been probed, particularly around the sale of credit insurance and the ability for retail financial products to provide customers with value for money. The FSB has focused its efforts on retail markets through the RDR, Complaints Management and Binder Regulations. These, as well as changes to the National Credit Act, are bringing a regulatory focus on retail conduct issues that South African firms should be conscious of.

Firms should be expressing their conduct risk appetites at an enterprise and Board level and ensuring that their ERM frameworks are adequately taking the risk of mis-conduct into account.

Wholesale Conduct RiskWholesale conduct risk represents the risk that the action or inaction of regulated firms or their staff creates undue detriment to their clients or to the integrity of the market.

The FSB is paying attention to risks associated with outsourcing within the value chain and the risks that outsourced parties pose for the primary financial institution.Firms are paying more attention to monitoring this risk and having a view around their residual risk profile.Understanding the outsourcing landscape of primary and secondary outsourced parties is key to ensuring that these risks are identified and managed appropriately.


• Promote the testing of the alignment of inherent and residual wholesale conduct risk with the conduct risk appetite as expressed by the Board

• Ensure that outsourced environments are well understood and that management have adequate programs in place to monitor the delivery of adequate outsourced services that do create risk for customers and the organisation

• Verify the risk, control and ERM frameworks supporting the management of conduct risks

• Test the key business controls that support the delivery of goods, outcomes for customers and clients

• Have a view of the residual risk posed by certain high risk products that are under regulatory scrutiny, particularly credit life.

Applicable sectors

Retail Banking

Capital Markets


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Consumer credit

Credit providers in South Africa have been hit by a number of recent changes to the National Credit Act.Other regulation, such as the RDR, will also have an impact on credit providers as products like credit life insurance come under regulatory scrutiny and fee disclosures to customer are improved.

The latest development within credit industry, the National Credit Regulations including Affordability Assessment Regulations, requires credit providers to:

• Verify income using recent three month’s income information

• Include minimum expense norms during affordability assessments or obtain consumer declared expenses questionnaire.

These changes have brought about an increase in compliance costs and have resulted in revenue pressures due to the increased complexity of the process.

The RDR is also proposing that certain products that are considered “low” or “no” advice products, e.g. credit life insurance, have minimum conduct standards in place to control the manner in which these products are sold in the market. Providers of credit products who have FSB-regulated insurance products sold alongside the credit will need to be conscious of these conduct standards to ensure they are compliant. This additional compliance cost may also weigh heavily on the profitability of these products.

What is the impact on credit providers?Credit providers have an obligation to demonstrate compliance and may require an overhaul of the control environment such as updating the credit lending risk methodology, updating marketing information and training staff. Management will also require verification that the controls implemented in response to the new compliance requirements are aligned to regulations and are operating effectively.

Where business models are subject to increased compliance costs and caps on chargeable fees, organisations will need to assess the target markets into which these products are sold, as well as the distribution strategies associated with them. Operational efficiency within the sales process and development of strong sales pipeline will be key to ensuring that firms remain profitable and retain market share.


• Verify that management have appropriate and robust oversight controls in place around affordability and credit worthiness that include a structured plan to check that risk escalations reach senior management on a timely basis.

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Retail Banking

Capital Markets


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Bank capital

Bank financial resilience remains priority for Regulators across the globe and with the Basel Committee on Banking Supervision finalising its proposals for its final package of rules on capital and risk management.

South African banks are keeping abreast of the developments regarding the proposed changes to the derivation of risk-weighted assets as it pertains to the move towards greater reliance on more standardised models (with a possible application of capital floors) with less reliance placed on internal calibrations.

Banks have commenced their preparations to ensure compliance with the impending IFRS 9 financial instrument accounting standard, set to come into effect in January 2018, as well as the fundamental review of the trading book (FRTB), final rules to be released during 2019. Both these developments have far reaching implications for not only model methodology, but also regulatory capital requirements, governance, systems and data.

Banks are currently assessing the impact of the FRTB and are reviewing the current target operating platform for market risk, taking into account platform capabilities across both front office and risk areas and aligning market risk processes, analysis and reporting in line with these impending regulatory changes. FRTB aims to address the shortfalls of the current regulatory framework and provide

substantial enhancements, not only to trading market risk capitalisation levels but towards the entire governance process.

Enhancing recovery and resolution planning (RRP) in the banking sector is still a priority supervisory area for the SARB. Banks were required to submit their RRPs for the first time in 2013 and are required to update their plans on an annual basis. The publication of the Special Resolution Bill is expected in the latter half of 2017, to give effect to the enhanced resolution powers given to the new regulatory bodies, per the draft FSRB. Firms are required to imbed the plans in business as usual processes, an area that has proven particularly challenging to some banks.

Capital and Liquidity

Applicable sectors

Capital Markets



• Internal audit are encouraged to keep abreast of these regulatory developments in order to provide assurance to the audit committee and the board on the organisations governance and control environment, as management enhance systems, data, policies and processes on its journey to compliance.



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SAM

The regulatory landscape for Insurers and Insurance Groups in South Africa is becoming more and more focused on the internal sophistication of risk quantification and management practices and the supporting infrastructure. Regulations such as SAM are forcing companies to consider the risk inherent in their business from a holistic risk-based perspective aimed at reflecting a ‘true’ picture of the inherent risk in a particular business. With the Insurance Bill before parliament and the impending implementation date contingent on the approval of the Twin Peaks legislation, the FSRB, firms are still in the process of implementing SAM and are currently in the comprehensive parallel run phase of implementation. In this phase firms are required to report both on a current regulatory reporting basis as well as on a SAM reporting basis (qualitative and quantitative templates) and submit their enhanced mock Own Risk and Solvency Assessment (ORSA) results, placing stain on already scarce resources.

The quantitative reporting templates, under the new SAM reporting basis and the current reporting basis, are required to be audited by external audit for the 2016 year-end regulatory reporting. In line with the firms reporting policies, internal audit should assess its responsibility for providing assurance to the audit committee and the board regarding the validity, accuracy and completeness of the regulatory reporting before submission to the FSB.

Firms are required to have a board approved ORSA policy which clearly states which sections of the ORSA will require independent review, either by Internal Audit or other independent parties. Firms were required to submit their enhanced mock ORSA to the FSB during 2016, however a lot of work is still required to ensure that the ORSA is embedded business-as-usual governance, strategic planning, performance management, risk and capital management processes in order to demonstrate that the results of the ORSA informs key strategic decisions. Internal audit’s role as independent validation are key to the governance process around the ORSA.

During the FSB SAM workshops towards the end of 2016, the FSB provided feedback on its initial reviews conducted on the mock ORSA reports it received from the industry. A number of shortcomings were highlighted, including, but not limited to, a lack of evidence of roles and responsibilities of key individuals in the ORSA process (including which areas of the ORSA require independent validation), board and senior management challenge of the results of various aspects of the ORSA process and necessary approvals required regarding capital and capital management and solvency targets.

Applicable sectors

Insurance


• Internal audit should pay specific attention to the shortcomings highlighted in the FSB’s reviews and assess the extent to which the organisation’s ORSA process may be subject to these findings as part of its planning for future reviews of the ORSA processes.

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icIntroduction

Resilience is not just an organisations ability to prepare for, respond to, and recover from adverse circumstances but also to withstand such disruption, maintaining the availability and performance of services and the IT that enables those services.

Organisations are facing increasing amounts of uncertainty and disruption, bringing both risks and opportunities, which more resilient organisations are better prepared to overcome and gain from. Regulators are asking how firms will be able to maintain client services in particular in controlling access management, managing change and managing service from IT vendors.

What is the impact on Retail Banking?Resilience is critical wherever customers and regulators expect high availability of services. Resilient Retail Banking systems improve services to customers and reduce the risk of regulatory intervention.

What is the impact on Capital Markets and Investment Management?Reliable, available and resilient systems are critical to maintaining an edge over competitors and liquidity in markets where quick response times and access to data underpins profitability.

What is the impact on Insurance?Insurers need to be sure that their customers are not impacted by any IT disruption.

Operational resilience


• Assess the organisation’s approach and risk appetite for resilience

• Assess the adequacy of the organisation's response plans

• Assess the technology architecture design for resilience

• Confirm that IT availability planning truly aligns with business requirements.

Operations and IT

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• Perform a diagnostic maturity assessment of the organisation’s approach to third-party risk management against good practice and regulatory requirements

• Assess compliance with existing third-party risk management policies and procedures

• Assess cloud risks and the mitigation of these risks

• Assess the governance maturity of third parties

• Assess contract risks.

Assurance over third-party management

Third-party risk has become a regular Board-level agenda item as a result of King IV and growing global regulatory attention around the use and control of third parties for key business activities.

Organisations need to be able to demonstrate their actions taken to manage third-party risk. In many cases there is limited oversight of the business-wide approach to, and success of, third-party risk management.

While organisations can outsource activities to third parties, they cannot outsource their risk. Inconsistency in approach and weak controls around third-party risk management can result in significant financial, reputational or regulatory damage as well as missed opportunities.

What is the impact across the FS sectors?King IV has heightened Board-level attention to third-party risk management. Some key areas that organisations have struggled with include expectations that:

• Risks of outsourcing into the cloud are understood and managed

• Obtaining adequate assurance from third parties regarding the governance of their processes

• There will be greater Board-level oversight, resulting in a need to enhance internal reporting processes and central visibility

• Risk will be managed throughout the third-party lifecycle. Many organisations are stronger in performing pre-contract due diligence than they are at managing the risk throughout the relationship.

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Cyber

Organisations' increasing reliance on third parties and mobile-computing in the provision of business critical services exposes them to an array of interconnected cyber security risks, triggering (in the complex of potentially negative consequences) a cascade of regulatory breaches in the process. Third-party incidents can lead to critical data breaches and service interruptions, which can have severe reputational and/or financial impact.

There is an increasing expectation from regulators, locally and internationally, that organisations understand and manage their cyber security risks effectively, which includes taking responsibility for third-party risks. In South Africa the FSB is focused on the risks posed, in general, to financial institutions by third parties.

Cyber risk has become key within such outsourced environments. In recent years the Protection of Personal Information Act (POPI) has seen more stringent measures being applied to how businesses handle, store and discard data about their customers – imposing requirements and consequences on those who abuse or are careless with the customer-sensitive data they manage and are charged to protect for/on behalf of others.

The SARB, in February of 2016, issued a guidance note to all banks, formally placing Cyber Security on their boards’ agendas; to be explored from a variety of angles over the course of the year.

The recently published King IV Report on corporate governance for South Africa recognises information in isolation of technology as a corporate asset that is part of the company’s stock of intellectual capital and confirms the need for governance structures to protect and enhance this asset. The legislated means to prevent and combat cybercrime in South Africa is defined in the bill currently in the process of being enacted, i.e. The Cybercrimes and Cybersecurity Bill.

This legislation underpins the National Cybersecurity Policy Framework (NCPF) for South Africa, which is “intended to provide a holistic approach pertaining to the promotion of Cybersecurity measures by all role players and will be supported by a National Cybersecurity Implementation Plan… The development and large-scale implementation of a system of security measures as implemented elsewhere in the world will form part of the National Cybersecurity Implementation Plan.”

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The findings from Deloitte’s 2016 Global Survey on Third Party Governance and Risk Management, which had representation from 170 organisations across different sectors, found that 87.3% of respondents have faced a disruptive incident with third parties in the last 2-3 years. The outsourcing and co-sourcing of IT services is inevitable to the smooth management of any organisational IT-service capability, but the risk factors associated with cybersecurity rise significantly for organisations when you take this kind of likely exposure to third-party risks into account. Embedding third-party cyber-risk programs, thus, allow firms to define and implement controls to manage this risk effectively and help reduce potential financial, regulatory and reputational risks.

Where cyber-risk is not managed, FS organisations are at risk of financial reporting errors, monetary losses, regulatory fines or penalties, breaches of sensitive customer data and service disruptions.


• Check that a comprehensive third-party risk assessment has been conducted, and use the ratings to develop the third-party security audit plan

• Review whether security standards have been adequately defined and incorporated into third-party contracts – including a right-to-audit clause

• Establish third-party security risk reviews as part of an ongoing internal audit plan

• Assess the degree of internal management control over the key IT service management processes and the internal policies which govern these.

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Project management

Constant change is the new reality with strategic transformation projects being a critical element of maintaining a sustainable business. Such initiatives place increasing demands on technology, necessitating large-scale projects to upgrade and replace aging legacy systems.

The success or failure of a project can have a substantial impact on reputation, business performance and the confidence of stakeholders.Internal Audit play a vital role in project reviews and challenging management on how project execution risks are controlled.


• Consider not just adherence to project management frameworks, but also: – Business Assurance: Project remains viable in terms of costs and benefits

– Programme Assurance: Delivering to agreed time frames and benefits

– Technical Assurance: Delivering a suitable solution for the needs of impacted stakeholders

– User Assurance: Meeting or achieving the user's requirements.

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Data Management and Governance

Data Management and Governance are the frameworks and systems in place to govern all of an organisations data assets and usage.

Recent and upcoming regulatory scrutiny (e.g. BCBS 239 and EU’s General Data Protection Regulation (GDPR)) and the changing data technology landscape mean that this is a key area of risk for organisations. King IV also specifically includes the need for information governance in its 12th principle.

A number of key risks and impacts are associated with ineffective data management and governance, including regulatory non-compliance (e.g. BCBS 239, GDPR which have explicit data management and governance requirements), cost and operational impact associated with poor data quality (e.g. high volumes of manual Risk & Finance reporting adjustments) and inaccurate reporting impacting both business decisions and regulatory submissions.

What is the impact on Retail Banking, Insurance and Investment Management?Under GDPR, new data privacy/protection activities are required which specifically link to compliance demands (e.g. a consumers “right to be forgotten”).

What is the impact on Capital Markets?Some G-SIBs are now required to comply with BCBS 239, meaning that the regulatory risk is now more tangible.

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• Understand the risks surrounding implementation of new data stores and management platforms

• Leverage both as analytics and the organisation’s consolidated data stores to drive more insightful and efficient internal audits/reviews.

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Digitisation

The usage of social media and mobile platforms is growing, and as a response, many FS organisations are investing heavily in digital transformation programmes to build or improve customer experiences. There is a trend for corporates to partner with small tech companies due to their agile and innovative digital solutions.

This has led to an organisations Risk and Audit functions being asked to evolve their practices to promote a balance between digital innovation and good governance.

What is the impact on Retail Banking?Retail banks are still at the forefront of digital governance and partnering with entrepreneurial tech companies in the FS industry and are expected to continue to lead in this space by helping shape best practice.

What is the impact on Capital Markets?Digital brings speed and agility for capital markets. The use of electronic trading through digital channels is growing. The underlying (legacy) trading infrastructure may pose challenges to support this growth.

What is the impact on Insurance?Selling and promoting insurance products through new digital channels will bring additional considerations, especially with the use of various parties such as agents and brokers who may have their own digital strategies.

What is the impact on Investment Management?Investment managers are increasingly using alternative digital servicing models to offer services to clients.

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• Provide assurance on third-party technology partners

• Assess the digital solutions available from third parties for partnering potential

• lnteract with the business to check that controlling mechanisms are in place for digital through strategy, governance, policy, awareness and monitoring.

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IFRS 9

IFRS 9 “Financial Instruments” is effective from 1 January 2018 and replaces IAS 39. There are three parts: classification and measurement; impairment and hedge accounting. Financial institutions see changes to impairment as the biggest challenge as the incurred loss model is being replaced with a three stage expected credit loss model. However, classification and measurement as well as hedge accounting should not be neglected as it has important ramifications for ALM strategies and economic hedging programmes.

Owing to the increased judgement introduced under IFRS 9, external auditors and regulators are becoming increasingly interested in how financial institutions will deliver a high quality implementation of the new rules. As such, Audit Committees are turning to internal audit functions to provide a level of comfort that key accounting policy interpretations and judgements are appropriate, key definitions are assessed, and that all required changes to systems and processes, including data requirements and internal controls, have been identified and tested so they are appropriate for use in IFRS 9.

What is the impact on Retail Banking?Retail banks will see higher and more volatile provisions, a weakening capital position and a significantly more demanding disclosure regime with the introduction of IFRS 9. Operating margins will be further squeezed due to the need to implement system and process changes across the bank. To offset this, retail banks will be considering strategies to strengthen and protect their revenue streams through product development and realigning risk appetite and business mix.

What is the impact on Capital Markets?The impact will be very similar to Retail Banking for corporate loan books. Corporate and central banks that issue financial guarantees or debt with large committed undrawn elements will see their impairment costs rise. Issuers of debt securities will be more closely scrutinised to assess their credit worthiness. Further P&L volatility may be introduced where assets are reclassified to a fair value treatment which may result in changes to product features.

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What is the impact on Insurance?Insurance companies without banking operations may defer implementing IFRS 9 to 2021 to align with the implementation of IFRS 17 Insurance contracts. However, banks with insurance arms will not be able to adopt this deferral option so they will see an impact on their retail and corporate books as detailed above. They will need to assess the classification of their insurance asset portfolios as part of their IFRS 9 programmes to prevent volatility due to their ALM strategy and product mix. Any hedging programmes will also need to be assessed in the context of IFRS9.

What is the impact on Investment Management?Funds will see a similar impact to Capital Markets, however, the scale of impact will depend on the assets within the fund and existing accounting policy treatment.


• Make an assessment of progress against IFRS 9 programme milestones and validation of programme governance

• Carry out a validation of build assumptions and interpretations for accounting policy, models, infrastructure, governance, and disclosures

• Conduct periodic reviews of model validation and experienced credit judgement frameworks.


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IFRS 15 is very detailed in comparison to IAS 18. The principles for revenue recognition under IAS 18 are broad and thus entities would need to use judgment in applying these principles. Under IFRS 15, entities follow a five step model framework in delivering the core principle; an entity will recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

When identifying and allocating different goods or services within a contract, the lack of specific guidance under IAS 18 resulted in greater room for judgment. Entities may have to amend their current accounting policies, as the new standard requires the revenue from a contract to be allocated to each distinct good or service provided on a relative standalone selling price basis.

As a result of these changes, there will be an impact on processes and information systems and there will be a need to capture increasing amounts of data.

Entities, if not already underway, should perform a business impact assessment for the move to IFRS 15.

Key actions include:

• Reassess contracts with customers

• Informing key stakeholders and investors

• Impact on processes, information systems, and data capture

• Training needs

• Transition approach

• Potential advantages/disadvantages or early adoption

• Disclosure impact of IFRS 15 ahead of adoption.

IFRS 15IFRS 15 “Revenue from Contracts with Customers” will replace the current revenue standard IAS 18. The application of IFRS 15 is mandatory for annual reporting periods starting 1 January 2018.

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Applying these new rules may result in significant changes to the profile of revenue and in some cases, cost reduction. As well as preparing the market and educating analysts on the impact of the new Standard, entities will need to consider wider implications. Among others, these might include:

• Assess the impact on financial reporting key performance indicators and other key metrics

• Changes to the profile of tax cash payments

• Availability of profits for distribution

• For compensation and bonus plans, impact on the timing of targets being achieved and the likelihood of targets being met

• Potential non-compliance with loan covenants.


• During the design and implementation phase, assess the adequacy of resources and required data, systems and process changes as a result of the transition to IFRS 15.

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IFRS 17 (previously known as IFRS 4) is an International Financial Reporting Standard issued by the International Accounting Standards Board (IASB) providing guidance for the accounting of insurance contracts. The main objective is to standardise insurance accounting globally to help users of accounts make sensible comparisons between companies, their past performance, their current financial position and risk exposures. For the first time, there will be a single IFRS accounting model for all types of insurance contracts that will be transparent and aligned to general IFRS accounting of other industries.

IFRS 17 covers how to calculate the liability for insurance contracts and will result in new profit signatures. This new IFRS for insurance liabilities combined with a new IFRS on financial assets (IFRS 9) will require massive transformation in finance, actuarial and IT systems in the insurance sector.

The implications of this IFRS transformation initiative are not just technical calculations, but will affect: Actuarial (reserving), Finance (general ledger), Tax (treatment), IT (data storage), HR (remuneration) and Investor Relations (presentations). The overall implementation plan for 1 January 2021 will need to consider the following valuation period assumptions:

• IFRS 17 B/S position requires as at 31/12/2019 in order to create FY2020 P&L (and opening position for reconciliation purposes)

• Full IFRS 17 financial statements for FY2020

• FY2021 will be the first published yearend IFRS 17 financial statements.

IFRS 17After a long development process, on the 18th May 2017 the International Accounting Standards Board (IASB) published IFRS 17, the new International Financial Reporting Standard for insurance contracts. The effective date for IFRS 17 is set for 1 January 2021; from that date IFRS 4 will be repealed.

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If not already in progress, insurers should conduct business and financial impact assessments of the transition to IFRS 17. Key actions include:

• Assess the impact of IFRS 17 adoption on data, systems and processes

• Evaluate the impact on financial reporting and actuarial modeling

• Informing key stakeholders and investors

• Impact on tax, remuneration and key performance indicators

• Identification of internal and consulting resources and in-flight projects

• Development of business cases and securing of budgets

• Training needs

• Transition approach

• Presentation and disclosure changes.


• During the design and implementation phase, assess the adequacy of resources and required data, systems and process changes as a result of the move to IFRS 17.

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The International Integrated Reporting Council published the Integrated Reporting Framework. The framework requires reporters to provide stakeholders with information relevant to the social, economic, governance, environmental and financial performance of their organisation. Material matters, assigned to the various capitals, should be detailed and the relevant performance outcomes and outputs disclosed over the period continuum.

Corporate reporting developments are placing greater emphasis on the non-financial performance and the respective ability to measure and detail such performance against predetermined targets.

Non-financial reporting processes are typically not as mature as traditional financial reporting, and may not be supported by robust systems and mature controls environments. All of which will need to be consider to improve the credibility, transparency and reliability of the information being reported to stakeholders.

Enhancing internal control and in particular the organisation’s nonreporting frameworks would help to mitigate a range of reporting risks, including:

• Multiple data sources

• Data quality – inaccurate or incomplete source data

• Incomplete reconciliation process and/or unresolved differences

• Inconsistent design and implementation of control standards

• Inconsistent output (e.g. between different regulatory returns or other regulatory submissions)

• Unexplained variances

• User identified errors.

As a result of this increased regulatory scrutiny, it is expected that enhanced internal control frameworks over all aspects of reporting and disclosure will continue to be a priority area of focus for both Audit Committees and Internal Audit.


• Demonstrate adequate coverage of end-to-end data quality and data mapping processes, including controls over the integrity of relevant data storage and transmission

• Assist with readiness assessments of management information's ability to be assured

• Form part of the combined assurance framework and play an active role in the assurance and reporting process as an assurance provider.

Non-financial reporting frameworks

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Conclusion

As the need for Internal Audit functions to provide more value-adding and strategic support increases, Internal Auditor needs to ensure that its work is aligned with both the strategic and operational risks that face organisations. Internal Audit functions should be agile enough to quickly adapt to a dynamic risk environment, while also meeting its planned risk-based assurance obligations.

We believe this publication will assist Internal Audit functions in its planning efforts and help focus the resources to enable a value-adding and strategic enabling Internal Audit function.

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Contacts

Contacts

Julie Akinyi NyangayaRisk Advisory Regional Leader: East AfricaMobile: +254 72 011 1888Email: [email protected]

William OelofseDirector:Risk Advisory East AfricaMobile: +254 20 423 0000Email: [email protected]

Contributors

James Alt

Nina le Riche

Francis le Roux

Andrew Warren

Nicole Jamieson

Akiva Ehrlich

Amisha Georghiou

Maria Kostelac

Claire Hoy

Martyn Davis

Anthony Smith

Keeran Maharaj

Thembakazi Tina

Gareth Goodleser

Raeesa Ismail

Natalie Hodgson

Stephanie Lafrance

Amit Bhana

East Africa

Anthony OlukojuRisk Advisory Regional Leader: West AfricaMobile: +234 805 209 0501Email: [email protected]

Temitope AladenusiDirector:Risk Advisory West AfricaMobile: +234 805 901 6630Email: [email protected]

West Africa

Tricha SimonRisk Advisory Regional Leader: Central AfricaMobile: +263 772 234 932Email: [email protected]

Rodney DeanDirector:Risk Advisory Central AfricaMobile: +263 867 700 0261Email: [email protected]

Central Africa

Navin SingManaging Director:Risk Advisory AfricaMobile: +27 83 304 4225Email: [email protected]

Nina le Riche TraillDirector:Risk Advisory AfricaMobile: +27 82 331 4840Email: [email protected]

Dean ChiversRisk Advisory Africa Leader: Governance, Regulatory & RiskMobile: +27 82 415 8253Email: [email protected]

James AltAssociate Director:Risk Advisory AfricaMobile: +27 72 163 9356Email: [email protected]

Southern Africa

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Deloitte provides audit, consulting, financial advisory, risk advisory, tax and related services to public and private clients spanning multiple industries. Deloitte serves four out of five Fortune Global 500® companies through a globally connected network of member firms in more than 150 countries and territories bringing world-class capabilities, insights, and high-quality service to address clients’ most complex business challenges. To learn more about how Deloitte’s approximately 245 000 professionals make an impact that matters, please connect with us on Facebook, LinkedIn, or Twitter.

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